In a discount interest loan , you pay the interest payment up front. For example
ID: 2651910 • Letter: I
Question
In a discount interest loan, you pay the interest payment up front. For example, if a 1-year loan is stated as $32,000 and the interest rate is 9.75%, the borrower “pays” .0975 × $32,000 = $3,120 immediately, thereby receiving net funds of $28,880 and repaying $32,000 in a year.
(Can you explain steps???)
What is the effective interest rate on this loan? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
In a discount interest loan, you pay the interest payment up front. For example, if a 1-year loan is stated as $32,000 and the interest rate is 9.75%, the borrower “pays” .0975 × $32,000 = $3,120 immediately, thereby receiving net funds of $28,880 and repaying $32,000 in a year.
Explanation / Answer
The effective interest rates you pay are a function of how much money you have available and how much money you give up for the use of these funds. In the simplest form of borrowing, a one-year loan of $ 10,000 at 12% interest will costs $ 1,200. The effective interest rate is $ 1,200 / $ 10,000 or 12%. As we change the costs and/or amount of funds available, the effective interest rate will change.
In the question asked above the effective interest rate would be
Interest charged = $ 3,120
Actual money received = $ 28,880
Effective interest rate would be = 3120/28880 = 10.80%